Whenever any full time investor shares his/her success story, I feel lots of questions coming out of his head. Lets start with which one bothering me most these days.

few words about me/and investing style - I work for an IT company, investing in stocks more than 3 and half year now, 99% invested in equity. For last 1 and half year doing fairly better than what I did before that. Changed portfolio style a lot from initial days; Now concentrated portfolio (currently 10 stocks, few months back had 6); 90% in micro/small cap and around 10% in mid cap. Now my portfolio mostly does not move with market correlation, there are times when market moves 1-2%, but my portfolio stays flat or negative; and big move comes when market is quiet. Overall performance is much better than broader index, but i see periodic under performance than others; so sometime get doubtful of my own conviction. Is this happen/common with other small/mid cap investors as well?

@sumit_tumba I have 70% small/micro cap and 30% midcap in a concentrated portfolio of 9 stocks. I feel exactly the same way you do. I am invested for the last year and half and have underperformed the index so far with gains of 10% overall. Daily movements are mostly not market correlated as you explained above.

Good points ... I too have faced the same issues those you have mentioned...But our conviction about the company and staying put irrespective of Index comparison ... will reward if the convincing story pans out as thought...

One thing we can notice the Mutual Funds have to give a reference Index and prove that they beat the Index... For that they Buy the stocks in that Index and play only with fund allocation ...

2-3 years is too little to draw any kind of deterministic conclusion on portfolio performance. Also, correlation with the index is completely irrelevant other than in broad market movements, when more or less everything goes up / down. So, don't look for any correlation.

Conviction should come from your study of the company and industry, not from price movement.

In my humble opinion, if any one is looking for leaving the job ONLY based on portfolio performance, minimum period one need to give is one full bull and bear cycle. This will test all our temperament, social pressure, passion and belief. Decision taken thereafter will be a matured and wise decision but not getting carried away with the success, which at times comes due to many other positive factors and not because of skill. Skill by definition is one which can help repeat performance. Hence to get sure about skill set available for the major life decision being taken is essential.

Yes, my experience has been similar. I guess the key is to not read too much into it and keep focusing on the specific business/story. However I must point out that the small & micro cap category gets hammered on days when the bottom falls off the market - days like the 6% fall on Aug 24, 2015 and Brexit day when the indices fell 4% intraday.

The very fact that you doubt yourself is a positive sign in my opinion, always doubt/second guess yourself but do not act until your analysis tells you that you must act.

Invrstr: thanks for you reply and analysis...if i get some reply from zygo too...then we can discuss the desirability and utility of developing such systems ...and how effective such systems can be for us in picking up good stocks

I started developing my weighted scoring system last year. Initially all the calculations happened in Google Spread Sheets. After sometime I realized that spreadsheet is falling short of many of my requirements. So I moved my data into a database and ran my system on my Raspberry Pi on my intranet. One thing led to another and I kept adding features as and when I needed them. Then I moved my site from intranet to internet so that I can access it from anywhere. Now it is available for anyone who wants to screen stocks.

I felt that everyone should have a system. So I built in flexibility in my system so that people can tune the weights as per their risk profile and mindset. Aggressive growth minded investors can keep the weights as growth, defensive investors who like dividends can chose the dividend oriented weights and value investor can choose value. Investor who dont want to spend time tuning can just use the default optimized settings.

Zygo: what piqued my curiosity was...as to how any quantitative system can catch the prospects of a company which is at an inflection point...or what in social sciences is called as pradigm shift.

How does a system take into account quality...and scondly shift in quality (from bad to good)..

Thats why i asked for analysis of a company which i believe to be at an inflexion point...a company whose future promises to be vastly different from its past.

The second aspect about your post was as to how you have Incorporated ideas of Mauboussin in your system. I too have read his books but i have not got much out of them...

Example of a company at an inflection point - check my post on the APL Apollo Tubes thread, other than this and Sanghvi Movers I haven't seen a huge delta coming through for any of the stocks I own. A basic question I ask myself -

Is demand for the business capex based or capacity utilization based? If the former you will have a business that will grow in spurts, else we have a secular business. A business that grows in spurts has a better chance of having a medium term future very different from the recent past if the demand environment is getting better and the effects of operating/financial leverage can play out in unison. However timing becomes important in such stories

As for how a quantitative model can catch such stories, this is what has worked for me. I have a DCF mindset to visualize how the financials can change if things were to get better. As for valuation I would swear by the reverse DCF method where you start with CMP and try to see what expectations are being priced into the stock. For e.g when I invested in APL Apollo in 2014 my analysis told me that the CMP was discounting a 11-12% growth in earnings and cash flow while I was fairly confident that the company would grow in excess of 25% once the commodity cycle had played out. To me the sacrosanct point is the difference between what is being priced and what I think the business can do

Applying Mauboussin fundas - my whole perspective on how long the DCF model period needs to be is driven off his fundas. If one invests with a 5 year horizon, it will be meaningless to consider a model horizon of < 6 years and too optimistic to model for > 10 years unless one believes the franchise component is very strong for the business. The link between ROIC, DCF period and implied growth rate is covered brilliantly in some of his notes.

I also use another simple framework of his to see if I am consistent in my buy execution -

Obviously one wants to enter when price momentum is strong (6-12M), quality makes the cut, valuation is cheap, re rating is underway and earnings momentum is getting better.

If one is holding a story where price momentum is very strong, Quality makes the cut, valuation looks expensive (priced in for positives) and re rating stage is late then any drop in earnings momentum can hammer the stock price (look at Cera Sanitary through H2 last CY)

That's the morningstar framework I use for specific businesses. In addition to this I do a basic porter's five forces for the industry segment and also look at the following in addition -

Is the demand for the business capex based or utilization based?Risk of Govt interference in pricing/licenses/resource allocationRisk of rapid technology obsolescence

When it comes to price momentum the thought process is this - I do not want to be too early into a story where I need to wait for 3-4 years for the market to come around to my view. If price momentum is there I know that interest levels are on the rise (of course only after business makes the cut on all other parameters) and that re rating has started. This way I may let go of the initial 2X gains but I am keen to capture the story from a market cap of 300 Cr to say 3000 Cr.

I bought APL Apollo only after price went to 330 from 150 and stayed there for some time. I also bought Garware wall ropes only after the price went up 2 - 2.5X to 250+. So I look for 6-12M price momentum where the re rating is currently being driven off EPS growth, so if and when the multiple re rating happens the effect on returns is spectacular.

Stage of re rating I like to triangulate from -

OCF/FCF yieldReverse DCFPlain old P/EIncremental return on capital (tends to be high when operating/financial leverage is present)

Note - This approach works only for businesses which have a long runway where one can afford to let go of the initial 2X gains, won't work for cyclical stories. Also this approach fits well with my own temperament, others may have to tweak the approach to suit their world view

Generally people who quit job these days are either full time traders or full time private equity investors(also called angel investors). In trading the posibilties of higher returns is lot more for smaller capital, but risks are also lot lot higher, so unless you are a well trained trader you shouldn't even think about it.

And for public equity investors I have seen many fund mangers suggest to have annual expense to be sufficed by dividents alone ie a portfolio size of 75-100 times of annual expenses.

Financial freedom defines that the returns above inflation rate should be enough to suffice your expenses ie if you get a returns of say 20% CAGR and if the inflation is 7% your expenses should be within 13%. But I don't quite believe in that philosophy as it doesn't grow your wealth at all if your spending all your returns.

Well, the best plan I have thought about is keeping a part into debt. The certainty of interest income will cover monthly expenses since dividend is not 100% risk free. e.g. $1m (Rs 6.5cr) is a good figure to consider retirement in metro cities like Mumbai. One can keep 1.5cr in debt to to get interest and reinvest dividend income in debt rather than equity. This is because I believe interest rates will keep falling in the longer term. Once you reach $2m + in equity, use dividend to cover monthly expenses and get rid of all debt funds and get into higher risk mode. Even steady 10% income on 10cr is ok to be happy about CAGR is just an ego booster unless someone wants to run PMS.